ENT640 Structuring Blog Week 5.
STRUCTURE’S BLOG from the book "Winning Angels, the 7 Fundamentals of Early Stage Investing"
There are 3 main structures.
1. Common stocks/units
2. Preferred convertible with various terms
3. Convertible note with various terms
Common stocks/units are the most common and the easiest to do, especially for a beginning entrepreneur like me. Preferred Convertible is preferred those who are more experienced (191).
“…What and who of your investment are far more important than the terms.” (182).
The preferred convertible is not simple, and you’ll need significant interaction with the entrepreneur. VCs don’t like this because it may mean additional issues to resolve before they invest. The preferred share structure offers way more protection to the investor. VCs require it.
The third structure is Convertible Note with Various Terms. This is becoming more common as financings are occurring in shorter time frames. This structure avoids a negotiation on the price and it doesn’t change the price of the common stock. This is a new structure that has a very positive exit impact.
“Don’t invest with anyone who under any circumstances might do something that you wouldn’t be proud of…” -Bill Sahlman (197). Entrepreneurs should prepare for failure just in case. Do not invest in more than you can afford to lose.
Bert Twaalfhoven said: “To make certain that you don’t do it alone, that you have others who have more experience, that he sticks on his investments within 200 miles, and that you give top priority to your manager entrepreneurs who run the company. Tie them to the venture with stock options and make certain that they have complementary experience.” (206).
Carry your one-pager. Any angel deal should be completed on one page before involving a lawyer (207).
Here’s What the Winners Do:
Complicated structures create complicated. Keep it simple. “Keep it very, very simple. You want to keep it very simple because the VCs get turned off by a complicated structure that they have to unwind or cannot do anything with.” -Warren Adams (198). Simplicity is best to maximize success. Keep it simple by having one page agreements. Make sure to always carry your one pager with you (205).
Here is what should go on your one pager:
1. Describe main elements of the deal between entrepreneur and investor
2. Capital structure
3. Involvement of the investor
4. Expected minimum time entrepreneur will stay in the business
5. Salary level for the entrepreneur until cash flow is positive
6. Reporting mechanism
This is the basis for the legal document and understanding between the two parties. It saves lots of time and legal fees.
Keep monthly reports from the entrepreneur part of the investment agreement (207).
According to Bill Sahlman’s interview, it’s more important making the right people and marketing choices than valuating negotiation and structuring.
Bill Sahlman said, “If you look at the positive scenario it doesn’t matter much what securities you use. If you look at the negative scenarios and my experience is that you lose 100% of your money in most of the companies you look at. Whether you have preferred stock or anything it doesn’t matter because there’s not much value left of the company anyway. So frankly I don’t spend a lot of time on that part of the process.” (213).
Amis, David, and H. H. Stevenson. Winning Angels: The Seven Fundamentals of Early-stage Investing. London: Pearson Education, 2001.